Produced in partnership with Ninety One 

The old perception of “risky” emerging markets and “stable” developed markets is being turned upside down as emerging market economies show more disciplined fiscal and monetary policy than many of their developed peers.

Archie Hart, co-portfolio manager for Ninety One’s emerging markets equity strategies, says investing in developing countries is at a “turning point”.

“The economic volatility and equity volatility of emerging markets versus developed markets has been falling over time, and it’s inherently a diverse asset class with a multi range of drivers,” he tells Investment Magazine.

The relatively cheap valuations of the emerging markets are a key attraction, but Hart says their fundamentals have also improved in two ways.

“There’s been a new generation of emerging market policy makers who are highly educated – often in the West – and are very conservative, very pragmatic,” he says.

“If you look at where we worry about imbalances, we worry about trade and fiscal imbalances in America and fiscal imbalances in France and Britain, whereas if we look at a lot of EM, they have actually pursued extremely conservative policy.”

For example, Brazil’s deployment of 15 per cent nominal interest rates since June this year to aggressively curb inflation has been read by the market as a demonstration of its credibility.

Secondly, emerging market companies have gone through a “generational change” where both their quality and variety have improved, Hart says. In contrast, developed market growth is “mono-themed” and essentially driven by AI companies and the US market.

“If you go back 30 years, a lot of our choices were state owned companies and in not particularly inspiring parts of the market like utilities, telecoms, mining or oil and gas,” Hart says. “Fast forward to today, and our opportunities are very largely privately owned companies run by entrepreneurs who just focused on being a profit maximisation.”

“Our portfolios today, probably around half of that is in the broadly defined technology [sector], so not just obviously electronics manufacturers or semiconductors, but things like biotech, aerospace, e-commerce, internet and gaming.”

Crucially, Hart warned investors against forming views about emerging markets based on point-in-time information. Since the MSCI created an emerging markets equity index in 1987, the asset class has experienced four long cycles with strong rallies and sell-offs at various points, he says.

“When people look at the asset class, they tend to extrapolate from wherever they are. When times are good, they say it’s going to be good forever. When times are bad, they say it’s going to be bad forever. And I think what that misses is the cyclicality,” he says.

“At the moment there’s a lot of negativity around the asset class, which is based on nothing more than historical performance that has been pretty poor for the last 15 years relative to a runaway developed markets asset class.

“We can see clear signs of a turnaround coming through.”

Impacts on allocators

According to Hart, a modest increase in allocation to emerging markets goes a long way towards making an investment portfolio more resilient. He notes that almost 70 per cent of the global equity asset allocation is now in the US, which is an extraordinary weight to be placed in a single country.

“To give you an idea about the implications of that, if investors were to take 5 per cent of the US equity allocation… and moving to EM, that would be a 30 per cent inflow into EM.” he says.

“You don’t actually need much diversification out of the US, to have quite a significant impact on EM as an asset class.”

A recent thought leadership piece from Ninety One also rejected the idea that emerging markets are just a quasi-bet on China. While it remains a large part of the index, the increasingly relevance of the EM ex-China universe highlights some of the strongest structural stories with other constituents, such as India, which doubled its index weight in the past five years and saw a boom in investable tech and internet companies.

“People talk about India and China in the same breath… but India is a fifth the size, economically, of China, which is certainly quite different. China’s almost becoming a middle-income country, and India’s still very much a lower income country,” Hart says.

“It’s useful to have a large number of countries aggregated, because it makes them relatively much more significant.”

An active approach is prudent in the emerging markets due to less institutional involvement and that it’s often retail investors who are on the other side of the trade, Hart says.

“If you look at the average EM manager over the long term, they tend to do better relative to their benchmarks than the average developed market investor. I’d love to claim that it’s because of our inherent genius, but it’s actually just because the markets are a lot less efficient, and that’s the opportunity for an active manager,” he quips.

“It’s not just that we have pretty good return picture [in EM] coming from much lower valuations, but actually we diversify and reduce overall risk by allocating to them. So there’s a really good story around EM allocation, both from a return and a risk perspective.”